1. “Transaction Cost Economics: The Natural Progression” Oliver E. Williamson American Economic Review June 2010, 100(3): 673 - 690 1.How is transaction cost economics different than neoclassical economics from Econ 302? 2.What is Williamson’s view of the nature of man? 3.The answer to Ronald Coase. 4.What is a transaction cost anyway? 5.Take away lessons.

2. How we work together to get things done without killing each other… What efficiency factors determine when a firm produces a good or service to its own needs rather than outsource? Why don’t we just have one big firm? The Nature of the Firm (1937) Economica 4(16):386-405 “The ultimate unit of activity…must contain in itself the three principles of conflict, mutuality, and order.” -- Commons “…governance is the means by which to infuse order, thereby to mitigate conflict and realize mutual gain.” -- Williamson

3. Transaction Cost Economics vs. Neoclassical Economics Organization Transaction Contract Market Price Choice “The chief mission of neoclassical economics is to understand how the price system coordinates the use of resources, not the inner workings of real firms” p. 674. Harold Demsetz James Heckman, left, Roger Myerson, Gary Becker and Robert LucasElinor Ostrom and Oliver Williamson

4. “…one of the things a scientific community acquires with a paradigm is a criterion for choosing problems that…can be assumed to have solutions…A paradigm can…even insulate a community from those socially important problems that are not reducible to the puzzle form, because they cannot be stated in terms of the conceptual and instrumental tools the paradigm supplies.” The Lens of Choice vs. The Lens of Contract Buchanan “…argued that economics as a discipline went “wrong” with its preoccupation with the science of choice and the optimization apparatus associated therewith. If ‘mutuality of advantage from voluntary exchange is …the most fundamental of all understandings in economics” then the lens of contract approach is an underused perspective. P. 674

5. “…be like Amundsen, not like Scott.” “All models are wrong, but some models are useful.” -- George Box

6. The Nature of Man reconsidered… Herbert Simon “Nothing is more fundamental in setting our research agenda and informing our research methods than our view of the nature of the human beings whose behavior we are studying…(this behavior is) intendedly rational, but only limitedly so.” Williamson: “Human actors are neither hyperrational nor irrational but are attempting to cope with complex contracts …most people will do what they say (and some will do more) most of the time without self-consciously asking whether the effort is justified by expected discounted net gains.” Limited Attention & The Optimal Incompleteness of Contracts Shari Gifford

7. “…the argument comes down to this: efficient intermediate product market exchange is usually well served by simple market contracting if the assets are generic; but the advantage shifts to hierarchy as bilateral dependence (and the resulting risk of costly maladaptations) builds up by reason of asset specificity and outlier disturbances.” p. 677 Generic & EasySpecific & Risky Transactions costs are higher when assets are specific and firms face a lot of risk. “Economic governance between distinct units becomes corporate governance within one unit.” Dixit p. 12

8. Market ContractingHierarchy Franchising is an allocation of decision rights & incentives based on minimizing transactions costs

9. Incentive IntensityAdministrative ControlContract Law Markets Hierarchy Franchising Can we classify organizations?

10. “Why can’t a large firm do everything that a collection of small firms can do and more?” p. 682 “The problem is that none of these promises is self-enforcing…” “Suffice it to observe that the breakdowns referred to above are often intuited by many intelligent businessmen and their lawyers who recognize the tradeoffs and factor them into the decision to integrate (or not)” p. 683.

11. What is a “transaction cost”? Search Negotiation Enforcement Legislation & Regulation Audit “A Transactions cost is any activity which is engaged in to satisfy each party to an exchange that the value given and received is in accord with his or her expectations.” Ouichi, Markets Bureaucracies and Clans

12. What are INTERNAL transactions costs? Allocation of decision rights: incentives and monitoring! Incentives: Monitoring, fall-out from failure Monitoring: Gaming the system, not monitoring what you’re really interested in. Hiring, firing, training “A Transactions cost is any activity which is engaged in to satisfy each party to an exchange that the value given and received is in accord with his or her expectations.”

13. “…much of what is interesting about human behavior in general and organizations in particular has reference not to routines, but to exceptions. Indeed, once good routines have been developed, the chief role of management is to deal with exceptions” p. 679. “…the ‘major importance of legal contract is to provide…a framework which almost never accurately indicates real working relations, but which affords a rough indication around which such relations vary, and occasional guide in case of doubt, and a norm of ultimate appeal when the relations cease in fact to work” p. 679. “The basic proposition is this: absent the use of credible commitments to support exchange, the contractural hazards associated with many transactions would be perceived to be excessive. Generic investments would replace transaction specific investments…some transactions would be taken into firms. Some would never materialize” p.684.

14. Key take-away points: 1. Make decisions to minimize transactions costs. 2. Think like Williamson: “be disciplined; be interdisciplinary; have an active mind… ask what is going on here? 3. DON’T WRITE OR PRESENT LIKE WILLIAMSON! Use smaller, more common words, give more examples, don’t have slides full of words!